Educational Articles

Shakeup at Hess Leaves One Less Refiner

Robert Mitkowski
| March 12, 2013

Hess (HES) is under pressure from a major shareholder to speed its transition to a drilling-focused company, from a more diverse operation that included refining and marketing. A number of oil companies have moved away from refining in recent years, including Marathon Oil (MRO) and ConocoPhillips (COP), which respectively set up Marathon Petroleum (MPC) and Phillips 66 (PSX) separate from their drilling operations. Murphy Oil (MUR) is also spinning off its fuels business to shareholders.

Hess’ move is similar in that it is looking to focus on drilling—where returns are typically higher. One difference is that Hess is closing its lone refinery, and turning it into a fuel depot, rather than keeping it as an ongoing concern. One might think that with refiners, such as Valero Energy (VLO), HollyFrontier (HFC), and Marathon making big profits these days, that there would be money to be made keeping Hess’ facility running. Maybe there is, but possibly not enough to justify the required upgrades for pollution control. The East Coast plant is a long way from the cheaper feedstock supplying mid-continent refiners, too.

There is still a chance Hess could sell its refinery. Although the company has stated the plant lost money in two out of the last three years, laid-off workers claim the $20 million earned in the one profitable year more than made up for the two unprofitable years, and are hoping a buyer emerges. The hurdle is likely to be an estimated $45 million in capital expenditures to comply with environmental regulations for low-sulfur heating oil. But there may also be grassroots support to keep the East Coast facility running, so as to keep a lid on gasoline prices. The refinery’s role in supplying fuel to the region in the aftermath of Hurricane Sandy may also count in its favor.

Whatever the case, Hess is moving on, and plans to trim its network of storage terminals and gasoline stations, as well, to become a pure-play oil and gas exploration and production company. To further narrow the corporate focus, the sale of drilling assets in Indonesia and Thailand is being explored. Given the expected proceeds, Hess has doubled its quarterly dividend and initiated a share-repurchase program of up to $4 billion.

The pending changes at Hess were accelerated by an activist shareholder, although they might have taken place over the course of time anyway. Hess still needs to execute its strategy, as well. From here, the company’s focus will be on up-and-coming onshore wells in the Bakken field of North Dakota and Ohio’s Utica shale formation, plus offshore drilling in the Gulf of Mexico, Malaysia, and Ghana.

But that doesn’t appear to be sufficient to satisfy the large shareholder who thinks Hess should be further broken up into two companies: one focused on drilling properties in the United States and another concentrating on international operations.

Whether additional changes are on the way or not will likely depend on what happens at this year’s annual shareholders meeting. Hess has proposed six new directors to take the place of the old guard, some of whom were associates of the company’s late founder, Leon Hess. But the hedge fund wants to put in its own slate of directors, who, if elected, would push for the further breakup of Hess. Either way, the company’s future will no longer include refining.

At the time of this article, the author did not have positions in any of the companies mentioned.